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17 Questions Answered About the DOL Fiduciary Rule Change

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17 Questions Answered About the DOL Fiduciary Rule Change

Written by: Brendan Furey and Michael Conlon

The following questions were raised to us about the new DOL Fiduciary Rule. We cover the DOL Fiduciary Rule in more detail in a previous post, but we thought we’d share. 

1. In RIA with Rollover, since AUM increases, but fees decrease or services increase then are you a conflict? Trusted advisor is increasing income, but client getting something for it.

A: This question seems to be asking when an Advisor is managing a client’s retirement plan assets and recommends a rollover to another vehicle, such as an IRA, since the Advisor’s assets under management (AUM) will increase but overall fees paid by the client will decrease, or services received by the client increase, then are you in a conflict? The Advisor’s compensation is increasing but the client getting something for it.

The recommendation of a rollover creates a potential for a conflict of interest. Therefore, the Advisor making the recommendation should document with the client why the rollover is in the client’s best interest. The fact that overall fees paid by the client will decrease, or services received by the client will increase with the rollover are good reason why the rollover is in the client’s best interest and therefore, should documented in the client’s profile and if it is not already in the client agreement, the client should receive notice that the Advisor is a fiduciary acting in the client’s best interest.

The definition goes on to explain what constitutes a “recommendation” and what may be excluded from that definition, such as providing certain services or information regarding the plan or IRA, such as marketing or making available to a plan fiduciary a platform or similar mechanism where the plan fiduciary may select or monitor investment alternatives; identifying investment alternatives that meet objective criteria specified by the plan fiduciary; providing objective financial data and comparisons with independent benchmarks to the plan fiduciary.

2. If an Advisor recommends that a client rollover from a 401(k), hence increasing the Advisor’s AUM and the client’s fees (regardless of investment), does not that create a conflict of interest?

A: Correct, the recommendation of a rollover creates a potential for a conflict of interest. Therefore the Advisor making the recommendation should document why the rollover is in the client’s best interest.

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3. How do you get the expenses of the 401(k) that the employee was paying?

A: Clients should be able to produce documentation regarding the expenses that they are currently paying for their 401(k) plan. The Advisor will want to collect the current fee structure of their client’s 401(k) plan as a factor in making an informed recommendation about why any rollover from that plan is in the client’s best interest.

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4. How do we get the expenses of the 401(k) to the client?

A: If you are trying to obtain information about a client’s 401(k) you should contact the plan sponsor. However, this question seems to be asking how do Advisors ensure they are not responsible for the expenses of a client’s 401(k).

Unless an Advisor is engaging clients in a “wrap fee” program, where the client pays a single advisory fee for the management and services of their account including custodian and brokerage fees, then the clients should be responsible for paying expenses related to the management of their account. Advisors should ensure that their client agreements and Form ADV Part 2A, Item 5(C) fully and accurately disclose which party is responsible for fees related to the account management.

Although an RIA may not be compensated by a commission or revenue sharing, Form ADV requires disclosure to clients regarding potential conflicts and compensation arrangements. Hybrid advisors receiving commission compensation will want to ensure they are satisfying the BICE. Therefore as a best practice we recommend that even firms without commission or revenue sharing fees should provide notice to retirement clients that they are providing their services in the client’s best interest to uphold their fiduciary duty and review and update disclosures of any potential conflict of interest. This will ensure that you are availing your firm of the BICE and creating a presumption of compliance with the Rule.

5. If I’m an RIA and already a fiduciary, and serve ERISA qualified plans as a 3(21) advisor and 3(38) manager capacity, and already have level fees fully disclosed and transparent within Advisory Agreements. (408b2 compliant), how am I really impacted by the DOL Rule? The only thing I’ve read is needing to document rollovers if I will get compensated for the rollover into an IRA (versus keeping funds in a 401k Plan, for instance) – which I already do to some degree.

A: Correct. The ongoing receipt of a Level Fee such as a fixed percentage of the value of a customer’s assets under management, where such values are determined by readily available independent sources or independent valuations, typically would not raise prohibited transaction concerns for the Advisor.

Under these circumstances, the compensation amount depends solely on the value of the investments in a client account, and ordinarily the interests of the Advisor in making prudent investment recommendations, which could have an effect on compensation received, are aligned with the Retirement Investor’s interests in increasing and protecting account investments. However, there is a conflict of interest when an Advisor recommends that a participant roll money out of a plan into a fee-based account that will generate ongoing fees for the Advisor that he would not otherwise receive, even if the fees going-forward do not vary with the assets recommended or invested.

As stated in question 1, for a level fee fiduciary to recommend a rollover the Advisor should document information supporting the recommendation in the client’s profile. Additionally, if it is not already in the client agreement, the client should receive notice that the Advisor is a fiduciary acting in the client’s best interest. It is our view that this written notice can also be communicated to the client via Form ADV.

6. Are there any best practices yet regarding the type of disclosure of the compensation arrangement and conflicts of interest (slide 13) – which I already disclose in our Firm’s ADV?

A: The best practices regarding disclosure of compensation arrangement and conflicts of interest will evolve as we get closer to the full implementation date of this rule, January 1, 2018. That being said, if you are not a level fee Advisor and seeking to make use of the Best Interest Contract Exemption you will want compensation arrangements and conflicts of interest disclosed in a separate Best Interest Contract or as an addition to existing agreements along with the other requirements of the Best Interest Contract Exemption.

Also in the preamble to the final rule, the Department of Labor recommended the creation of web disclosure, which they state should contain: A schedule of typical account or contract fees and service charges, and a list of product manufacturers with whom arrangements have been made to provide payments to the Advisor, including whether the arrangements impact Advisor compensation. The DOL also suggests disclosure of the business model and the Material Conflicts of Interest, including payout grids and non-cash compensation and rewards.

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7. Not sure if you covered this…. what about my existing clients that generate trails?

A: At this time we do not believe that trail compensation from commission transactions based on prior recommendations would be relevant to the DOL Rule change. If it is in the client’s best interest to transition those assets to another vehicle, or if a new recommendatio that would involve a commission trail should arise, those would be relevant to your compliance for your fiduciary duty and the DOL fiduciary rule, respectively.

8a. [Is there a] Conflict if [a] Fee Only RIA is NOT advisor to the qualified plan but solicits retiree to rollover to IRA? (the value added is RIA gives advise (sic) whereas existing qualified plan does not give that advice.

A: The recommendation of a rollover of retirement plan assets creates a potential for a conflict of interest. Therefore, the Advisor making the recommendation should document why the rollover is in the client’s best interest. Advisors should also be aware if any of their solicitors are making such recommendations and ensure they have documentation to support the recommendation. The statement that the IRA has more options available to it for investment, and therefore more opportunity for different strategies by means of advisory services from the RIA, can be given by the Advisor that the rollover may be in the client’s best interest given the full profile of the client.

8b. Does DOL recognize that distinction?

A: Yes. The DOL Fiduciary Rule would consider you to be a Level Fee Advisor.

8c. Am I giving client that disclosure or just adding to my ADV and client file?

A: Form ADV should be completely and accurately disclosing fees charged by the Advisor in Item 5, and any other compensation received in Item 14. Advisors are typically required to deliver Form ADV to all new clients, and existing clients annually or upon a material change. The DOL Fiduciary Rule would require full disclosure of all fees related to a client’s retirement plan assets when certain recommendations are made, such as a rollover.

9. Are [these] rules [applying] to discount brokers or robo advisors?

A: The DOL Fiduciary Rule applies to anyone making the recommendations to clients in qualified plans for a fee. ERISA contains an exemption to prohibited transactions in section 408(b)(14) that covers robo-advisors and is available for robo-advice involving prohibited transactions if its conditions are satisfied. However, robo-advisors that are Level Fee Fiduciaries may rely on the Best Interest Contract Exemption with respect to investment advice to engage the robo-advice provider for advisory or investment management services for Plan or IRA assets, provided they comply with the conditions applicable to Level Fee Fiduciaries, as discussed in question 1 above.

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10a. Doesn’t the rule impose a significant burden on the fee only RIA to know the fees charged in the 401(k)? Sometimes is it very hard to find this out fully. Clients don’t always provide this information and it is not always correct.

A: The new rule sets forth a requirement for certain information when making a recommendation to Retirement Investors. It requires that the Advisor, when providing investment advice to the Retirement Investor, that at the time of the recommendation, such advice reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor. Therefore, we would recommend performing all the necessary due diligence, whether with the client or directly with the plan sponsor of the client’s 401(k) in order to substantiate the recommendation(s) made, including current fee structure on 401(k) plans affected by the advice.

10b. Since we have no access to the 401(k), how do you confirm the information?

A: As stated in question 10a above, due diligence requirements should include gathering information from all sources available including contacting the sponsor of the plan, if needed.

11a. What do you mean by “level fee” advisor?

A: Level fee advisors are those that meet the definition of a level fee fiduciary by receiving the same compensation regardless of the particular investments the client makes, whether based on a fixed percentage of assets under management or a fixed dollar fee.

The full definition of a Level Fee Fiduciary is located in Section VIII(h) of the Best Interest Contract Exemption Final Rule

11b. Are you talking about an AUM %? or something else?

A: An Advisor whose compensation is based on the client’s assets under management would be an example of a Level Fee Fiduciary for the purposes of the DOL Fiduciary Rule.

12. Does the ADV Part II provide adequate disclosure for fee only RIAs?

A: It is our view that this written disclosure can also be communicated to the client via Form ADV.

13. Would an RIA be considered a level fee fiduciary if they charge differently for equities/bonds/cash?

A: Based on the definition of Level Fee Fiduciary above that does not sound like it would meet the requirements for the purposes of the DOL Fiduciary Rule since the Advisor would receive different compensation depending on what investments were made.

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